Why the Federal Reserve Won’t Commit
Mark Carney, the former Bank of England governor, was once labeled the United Kingdom’s “unreliable boyfriend” because his institution had left markets confused about its intentions. Jerome H. Powell’s Federal Reserve circa 2023 could be accused of a related rap: fear of commitment.
Mr. Powell’s Fed is in the process of raising interest rates to slow the economy and bring rapid inflation under control, and investors and households alike are trying to guess what the central bank will do in the months ahead, during a confusing economic moment. Growth, which was moderating, has recently shown signs of strength.
Mr. Powell and his colleagues have been fuzzy about how they will respond. They have shown little appetite for speeding up rate increases again but have not fully ruled out the possibility of doing so. They have avoided laying out clear criteria for when the Fed will know it has raised interest rates to a sufficiently high level. And while they say rates will need to stay elevated for some time, they have been ambiguous about what factors will tell them how long is long enough.
As with anyone who’s reluctant to define the relationship, there is a method to the Fed’s wily ways. At a vastly uncertain moment in the American economy, central bankers want to keep their options open.
Fed officials got burned in 2021. They communicated firm plans to leave interest rates low to bolster the economy for a long time, only to have the world change with the onset of rapid and wholly unexpected inflation. Policymakers couldn’t rapidly reverse course without causing upheaval — breakups take time, in monetary policy as in life. Thanks to the delay, the Fed spent 2022 racing to catch up with its new reality.
This year, policymakers are retaining room to maneuver. That has become especially important in recent weeks, as strong consumer spending and inflation data have surprised economists and created a big, unanswered question: Is the pickup a blip being caused by unusually mild winter weather that has encouraged activities like shopping and construction, or is the economy reaccelerating in a way that will force the Fed to react?
Mr. Powell will have a chance to explain how the central bank is thinking about the latest data, and how it might respond, when he testifies on Tuesday before the Senate Banking Committee and on Wednesday before the House Financial Services Committee. But while he will most likely face questions on the speed and scope of the Fed’s future policy changes, economists think he is unlikely to clearly commit to any one path.
“The Fed is very much in data-dependent mode,” said Subadra Rajappa, the head of U.S. rates strategy at Société Générale. “We really don’t have a lot of clarity on the inflation dynamics.”
Data dependence is a common central bank practice at fraught economic moments: Officials move carefully on a meeting-by-meeting basis to avoid making a mistake, like raising rates by more than is necessary and precipitating a painful recession. It’s the approach the Bank of England was embracing in 2014 when a member of Parliament likened it to a fickle date, “one day hot, one day cold.”
What is inflation? Inflation is a loss of purchasing power over time, meaning your dollar will not go as far tomorrow as it did today. It is typically expressed as the annual change in prices for everyday goods and services such as food, furniture, apparel, transportation and toys.
What causes inflation? It can be the result of rising consumer demand. But inflation can also rise and fall based on developments that have little to do with economic conditions, such as limited oil production and supply chain problems.
Is inflation bad? It depends on the circumstances. Fast price increases spell trouble, but moderate price gains can lead to higher wages and job growth.
How does inflation affect the poor? Inflation can be especially hard to shoulder for poor households because they spend a bigger chunk of their budgets on necessities like food, housing and gas.
Can inflation affect the stock market? Rapid inflation typically spells trouble for stocks. Financial assets in general have historically fared badly during inflation booms, while tangible assets like houses have held their value better.
In the Fed’s case, it is not even clear which data will matter most as it decides future policy. Officials cite a range of figures on inflation, consumption, jobs and wages when they talk about their outlook.
Mr. Powell is likely to stick to that open-ended script this week — but markets will still watch him closely for any clearer signal about what comes next.
Policymakers have recently slowed the pace of rate increases, making a quarter-point move in February after months of larger adjustments. Many Fed officials have implied that they will stick to quarter-point moves going forward, focusing on how high rates will ultimately go rather than how quickly they will get there.
But the prospect of resuming larger moves at the Fed’s meeting this month is not completely dead. “I’m open-minded, at this point” about a quarter-point or half-point move, Neel Kashkari, the president of the Federal Reserve bank of Minneapolis, said at an event last week.
During his testimony, Mr. Powell will most likely not “fuel speculation” that a bigger, half-point move is coming while also “not excluding” the possibility of a bigger move in the future, Krishna Guha, an economist at Evercore ISI, wrote in a preview.
Fed watchers will also be listening for a signal about how high rates are headed. Central bankers have suggested that the recent inflation and hiring figures could prompt officials to push borrowing costs higher than the range of 5 percent to 5.25 percent that they forecast in their December economic projections — but they haven’t declared that definitively.
Mr. Powell may hint that higher rates are becoming more likely, economists think, but he’s unlikely to firmly forecast a specific number.
“We’re living in a world of significant uncertainty,” Mr. Powell said at his last news conference, in early February. “We’re trying to make a fine judgment about how much is restrictive enough.”
Making that “fine judgment” has gotten more complicated in recent weeks.
Policymakers have raised rates aggressively over the past year, to above 4.5 percent from near zero a year ago. Fed officials thought that lifting rates so high would slow growth — and that they would soon be able to stop increasing borrowing costs.
A cool-down did seem to be taking hold toward the end of 2022. Inflation was slowing with each passing month, consumers were pulling back and hiring had moderated gradually but notably.
Understand Inflation and How It Affects You
But the start of 2023 threw a wrench in the narrative. Employers added more than half a million workers in January, inflation has shown signs of firming and consumer spending has come in strong across an array of measures.
That has raised a question: Is the Fed’s policy rate high enough to meaningfully restrain an economy with this much momentum? And it has left central bankers watching carefully to see whether the strength will reverse.
“It’s hard to talk about policy as restrictive — or sufficiently restrictive — when the forward momentum in the economy is so strong,” said Neil Dutta, an economist at Renaissance Macro. “And, more important, inflation hasn’t been resolved at all.”
Wall Street bets range widely when it comes to where the federal funds rate will be at the end of the year. Investors are penciling in anything from 4.5 percent to above 6 percent.
Economists at Goldman Sachs wrote in a note this week that if consumption continued to pick up, rates might need to rise to a range of 5.75 percent to 6 percent in order to slow the economy enough to bring inflation under control.
Central bankers have time to stay vague ahead of their meeting on March 21-22, and good reason to do so: Officials will receive a fresh reading on labor conditions on March 10 and fresh consumer price inflation data on March 14.
Those could shift the economic narrative somewhat.
“I would be very pleased if the data we receive on inflation and the labor market this month show signs of moderation,” Christopher Waller, a Fed governor, said in a recent speech, adding that he was looking for signs that the latest figures “were just a bump in the road.”
Still, he warned that “wishful thinking is not a substitute for hard evidence.”
And the Fed’s window to watch, wait and retain wiggle room is narrowing. Policymakers are scheduled to put out a fresh set of quarterly economic projections alongside their rate decision on March 22.
Those will show how high they expect interest rates to move in 2023 — illustrating whether they think rate moves will stop after May, the endpoint implied by their latest projections.
In short, the Fed might be playing coy for now, but the time to commit is coming.
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